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How is US currency worth anything?

CaptainManacles

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CaptainManacles
Joined
Apr 21, 2005
Messages
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So, that's all really, how is US currency worth anything? I often think of it as a game with cards and chips, with some end objective for a combination of cards you are suppose to have. In all versions of the game you can trade cards and chips with other players. But in one version you can trade the chips for cards out of some middle pile and in another the chips cannot be used for anything but trading with other players. It would not take very long in the latter version for players to realize the chips are worthless and shouldn't be accepted in a trade for cards. I fail to see how our currency is any different, I worry that the size of the card game just makes it take longer for everyone to realize they're exchanging notes of no value.

Though this seems to be well accepted as wrong and crazy and I'm not an economist, so, the question is, why is our currency worth anything?
 
Primarily because people will give you stuff for it. A secondary reason is people need it to buy oil.
 
CaptainManacles said:
So, that's all really, how is US currency worth anything? I often think of it as a game with cards and chips, with some end objective for a combination of cards you are suppose to have. In all versions of the game you can trade cards and chips with other players. But in one version you can trade the chips for cards out of some middle pile and in another the chips cannot be used for anything but trading with other players. It would not take very long in the latter version for players to realize the chips are worthless and shouldn't be accepted in a trade for cards. I fail to see how our currency is any different, I worry that the size of the card game just makes it take longer for everyone to realize they're exchanging notes of no value.

Though this seems to be well accepted as wrong and crazy and I'm not an economist, so, the question is, why is our currency worth anything?
Click to expand...

Well the fool is essentially correct; because people will give you stuff for it. To elaborate a bit, you need some form of currency because exchanging good and services directly for some other good or service is impractical in a modern economy. US currency or any other currency serves that purpose well because you can trust the government to keep the value of the dollar relatively stable. Stability is here compared to good, not to other currencies, and by stable I mean it does not fluctuate wildly rather than the total absence of inflation. Also you can trust the government to ensure that your dollars are in fact dollars - that is protect against counterfeiting.

You can basically think of money as a commodity like any other. It's a commodity/service that eases transactions. It makes perfect sense to pay for this good, just like it makes sense to pay for a car that makes transport easier. It’s all based on trust of cause, but as long as this trust exists the system works well.
 
I'm an economist. The value of money is basically decided by offer and demand.

Actually there's a number of different theories on why money has (or should have) 'value'. I'll just give you the simplest and probably best here.

Money is 'valuable' because we (the people using the money) give that value to it. Because we need money to achieve any sensible amount fo division of labour.

If the entire society of the US agrees that tomorrow, every coconut will be worth 5 dollars, then you could go buy groceries with coconuts. Since you agree the coconuts are valuable, you do not easily part with them. And the grocery store clerk also thinks the coconuts are valuable.

And coconuts are a lot more useful than fancy pieces of paper. Paper just serves the task as a currency better, it can be easily stored and carried around.

There's also the concept of legal tender. Basically it means that for certain cases (i.e. paying taxes, fees to the gvt, or paying damages and compensation, a specific currency has to be used)

Basically, the question of why money has value is easy to answer if you realize that we really, really, really need money. A society without money wouldn't be remotely as productive since everyone had to resort to bartering, and bartering is an infinitely more inefficient process. Try being a barley farmer and buying a car with 500 tons of barley. What car dealer has use for 500 tons of barley? The entire economy would break down to people who are self-reliant just to survive, we'd fall back 5000 years of technological achievements. So we really need money.

How much money is worth is a much more interesting question. The quantity theory gives you the answer. I'll break it down for you.

Basically, say an economy produces and sells 100 apples a year. To sell those 100 apples, you need at least 100 units of currency. So either 100 one-dollar bills or 100 one-cent pieces. Or 100 coconuts. So to sell 100 apples a year 100 units of <currency> have to travel around.

ware production = money supply
100 apples = 100 coins

Now currency, made from paper or coin is pretty handy. You can reuse it. You can get away with only 50 coins for example, and then the coins simply have to change hands another time.

goods changing hands = money supply * turnover speed
100 apples = 50 coins * 2

So what you can calculate now is the price niveau

( money supply * turnover speed) / goods changing hands = price niveau
(50 coins * 2) / 100 apples = "one apple per coin"

This all resolves to the quantity theory:

price niveau * goods changing hands = money supply * turnover speed

Now as you can easily calculate now, when the money supply or the turnover speed of the money double, ceteris paribus, the price niveau also has to double (since the ware production does not automagically double) this is what you call inflation.

inversely, if the ware production doubles, to keep the equation right, the money supply, the turnover speed, or the price niveau have to adapt. (double the money, double the turnover, or massive deflation)

Basically the problem of the economy in the world (the problem of "capitalism", whatever that may be) is that with reducing interest rates (reducing scarcity for goods, increased wealth) the turnover rate for money constantly decreases. This leads to the constant threat of deflation, which means mass unemployment, crisis and nazis or commies that take over the country.

National banks react to this by increasing the money supply constantly. They simply print new money. So you have an always-somewhat-high inflation rate. If you're saving money, that sucks, but since it's just paper, it's better than trying to keep the prices 100% stable in the long run and risking grave depressions.

A few more bullets:

- Gold, silver, metal etc are horrible as currencies since their supply can't be increased randomly, thus economic disasters are pre-programmed. The whole 'gold buillon backing paper currency' is unnecessary and was simply introduced as a compromise between a gold/silver based currency and a pure fiat money.
- The dollar is going down because there's too much of them without production going up to match ("growth") similiarly, oil is going up mostly because of the dollar losing its value quickly, and all oil is traded in dollars. If iran decides to trade oil in euros, or the chinese try to get rid of their vast dollar reserves, you can really say good bye to the value of your savings.
- You can use used toilet paper as currency. the only important thing about currency is that other people accept it, that it's handy, and that its supply can be controlled as to prevent random inflation. If you declare potatos to be currency, and everyone can grow them, then there would be so much inflation until no one would accept potatos as currency anymore.
 
Dabljuh said:
- The dollar is going down because there's too much of them without production going up to match ("growth") similiarly, oil is going up mostly because of the dollar losing its value quickly, and all oil is traded in dollars. If iran decides to trade oil in euros, or the chinese try to get rid of their vast dollar reserves, you can really say good bye to the value of your savings.
Click to expand...

So why doesn't Iran do just that? Any particular reason why an oil-producing country wouldn't accept euros or yen for that matter?

In the case of the Chinese, it would probably hurt them more than the US, and would mean that their currency would rise substantially against the dollar, which would hurt their export industry.
 
In an international sense, the dollar is worth something because we are in feedback loops with the Asian markets and energy exporters. The account deficits with China, Japan and Saudi Arabia are a loop because they have no choice but to reinvest USD reserves back into US securities and markets to prevent their own currencies from appreciating and making exports less competitive. As I understand it, it's basically vendor financing on a massive scale. And as with vendor financing, the vendor often has no good way of assessing risk. The alternative is watching your economic output plummet with evaporation of demand.

It's a nice idea to think that alternate currencies could be used, but essentially for international trade to take place there must be a reserve currency, which means somebody has to be running an account deficit. The Euro is not even a decade old while the USD has been off Brenton-Woods for over three decades positioning itself as the global reserve currency. Perhaps over time the Euro will disseminate as a reserve currency to compete with the USD, but consumption and uniform economic policy in the Euro zone is not likely to eclipse the American market. Richard Duncan made a very good argument for a global minimum wage to more realistically distribute wealth among producers and consumers, but that means, dum dum dum, global government.
 
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Dabljuh said:
- Gold, silver, metal etc are horrible as currencies since their supply can't be increased randomly, thus economic disasters are pre-programmed. The whole 'gold buillon backing paper currency' is unnecessary and was simply introduced as a compromise between a gold/silver based currency and a pure fiat money.
Click to expand...

Given the "backing" by gold is only useful, in theory, if you have an actual paper note = a declaration there is a corresponding actual lump of gold in a vault somewhere that this note controls, it doesn't do much good with electrons in a database somewhere representing your dollar.

In other words, if things start to collapse, you have no money, i.e. no gold, unless you have an actual paper dollar. Hence its value is limited in a modern type economy. This was the problem with bank runs and collapses -- people drew out savings, which caused the bank to foreclose on loans to get money back to pay out, people didn't have it, end of story. Gold backing doesn't help that situation whatsoever. Gold was there to slow or stop inflation.

Cynics, of which I am, point out that slowing or stopping inflation hurts those who borrow, who have the value of what they borrow be whittled away by inflation. E.g. my dad's $18,900 2-story colonial from the '60's, with its $230 payment, huge for the time, was a light joke at the end of his 30 years. And the largest borrower, who gets the best rates because they can secure their loans not with collateral, but the legal power to tax, gains the most advantage from this.


- The dollar is going down because there's too much of them without production going up to match ("growth") similiarly, oil is going up mostly because of the dollar losing its value quickly, and all oil is traded in dollars.
Click to expand...

IIRC, Bush's policy, unlike Clinton or Bush, Sr., was to let the dollar plummet to make it harder for countries like China and whoever else, to extract their profits from the US. This would have the net effect of making them invest in US projects more, which slows the collapse of the US economy as far as manufacturing, R&D, etc. is concerned.

Brilliant or horrible, I don't know.

If iran decides to trade oil in euros
Click to expand...

Per supply and demand, only useful insofar as other people want to buy those Euros from Iran, or Iran has something to spend them on in Euro-using countries. As crappy as the US economy is currently, it's still not as bad as Europe's. US is still preferred as an investment location, though it may be sub-par compared to China at the moment.

or the chinese try to get rid of their vast dollar reserves, you can really say good bye to the value of your savings.
Click to expand...

It's like saying "Bill Gates is worth $100 billion". Well, on paper, yes. But if he attempts to sell more than a tiny fraction of that, the value of MS stock plummets because people wonder what the hell's going on.

If China tried to unload (or Britain or The Netherlands, for that matter), the value would similarly plummet. It would be a stupid move on their part, from their own self-interest.
 
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Dabljuh said:
- The dollar is going down because there's too much of them without production going up to match ("growth") similiarly, oil is going up mostly because of the dollar losing its value quickly, and all oil is traded in dollars. If iran decides to trade oil in euros, or the chinese try to get rid of their vast dollar reserves, you can really say good bye to the value of your savings.
Click to expand...
That's a curious assessment coming from an economist.

Iran could change their trading currency to Angolan kwaanzas for that matter and it probably wouldn't materially affect the value of the dollar as a trading currency. That's because Angolan kwaanzas would still have to pass through the settlement banks and I'm pretty sure they'd have to convert them into US dollars.

For the Chinese to "dump" their reserves or (probably more importantly) their Treasuries, they'd still have to find a buyer that wasn't going to use US dollars.

The euro has certainly come a long way as a balancing currency among global reserves but I can't see it actually replacing the US dollar any time soon. Is there something you have seen to indicate otherwise? More importantly, why? If it's merely political, then that's a game, and one that currency speculators are probably better at than politicians are.
 
Beerina said:
Per supply and demand, only useful insofar as other people want to buy those Euros from Iran, or Iran has something to spend them on in Euro-using countries.
Click to expand...
Considering the dollar's continued decline relative to the Euro, it seems enough people want to buy Euro's. And Iran has major European trading partners.

As crappy as the US economy is currently, it's still not as bad as Europe's. US is still preferred as an investment location, though it may be sub-par compared to China at the moment.
Click to expand...
Many central banks that buy dollars do so to stimulate their own exports, or because they already own many dollars and don't want to see those evaporate.
And what's wrong with Europe's economy? The only bad news I heard recently was a slowdown due to global fallout from the subprime mess. I expect the US to get burned more, since they're closer to the fire. And the Euro has a major stability advantage over the dollar because it requires government deficits to remain below 3%. In addition to the much smaller trade deficit.

If China tried to unload (or Britain or The Netherlands, for that matter), the value would similarly plummet. It would be a stupid move on their part, from their own self-interest.
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Not necessarily, for two reasons. If the dollar continues to decline, and it will if current US policy does, then all those who own dollars will see their dollars vaporize anyway. But the one to get out first loses least. And sooner or later someone will.
Second, you assume all parties' goal is to maximise the value of their financial holdings. But in reality countries often have other priorities. For example, if the US ever tries to put political pressure on China over Taiwan, expect China to counter by threatening to sink the dollar.
 
stilicho said:
The euro has certainly come a long way as a balancing currency among global reserves but I can't see it actually replacing the US dollar any time soon.
Click to expand...

I don't think so either, for the simple, and apparently often overlooked reason of stability. Let us imagine a scenario where a USD meltdown spurred by energy shock and credit woes does spark a serious global economic recession. What happens in America? The USD stays, albeit with deteriorated buying power abroad. What happens in Europe in a recession scenario? You get fringe parties calling for unilateral withdrawal from the Euro which could permanently sink the currency. If nothing else the USD is perceived as being stable in the long run vis-a-vis the Euro, which is a voluntary currency confederation.

My somewhat simpleton understanding of global economics is that the American economy is kinda like the neighborhood mafia boss demanding gratuity from everyone else for providing some kind of perceived security and continuity. Nobody likes him, but that's the way it is with no alternative.
 
Beerina said:
Per supply and demand, only useful insofar as other people want to buy those Euros from Iran, or Iran has something to spend them on in Euro-using countries. As crappy as the US economy is currently, it's still not as bad as Europe's. US is still preferred as an investment location, though it may be sub-par compared to China at the moment.
Click to expand...

I still don't see why not. Now the US has sanctions on Iran, so it would seem to be harder for them to spend dollars than euros, yen or renminbi. If Giselle Bundchen wants to be paid in euros, why wouldn't Iran? Why would Iran not take an opportunity to stick its finger in the eye of the Great Satan?

I find stilicho's analysis on this pretty persuasive.

Paul Krugman also blogged about the dollar
 
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stilicho said:
The euro has certainly come a long way as a balancing currency among global reserves but I can't see it actually replacing the US dollar any time soon. Is there something you have seen to indicate otherwise? More importantly, why?
Click to expand...
Because with a much smaller trade deficit and government budgets treaty bound to have smaller deficits the Euro is a more stable currency. If you have a savingsaccount you're better off having it in Euro's than in dollars.
 
I get the feeling that some of the ones stirring up alarms about the "collapse" of the dollar have investments in gold...
 
How is US currency worth anything?! Good heavens, just think how much cocaine has been snorted through each and every bill! At the very least it'll always be worth a mild contact high.
 
Dabljuh said:
I'm an economist.

The dollar is going down because there's too much of them without production going up to match ("growth") similiarly, oil is going up mostly because of the dollar losing its value quickly, and all oil is traded in dollars. If iran decides to trade oil in euros, or the chinese try to get rid of their vast dollar reserves, you can really say good bye to the value of your savings.
- You can use used toilet paper as currency.
Click to expand...


So you confirm that, for example, trading Oil in
Euros instead in Dollars (like Saddam did) would
be a huge threat to the Dollar - a threat which
would be big enough to go to war? :confused:

And do you agree that Ron Paul is right and this
isn't just fear-mongering: ?


So what are the solutions if Gold backing the
Dollar would be too inflexible for a healthy
economy if the FIAT system is a much bigger
threat to the economy since it's able to destroy
the currency - while this isn't the case with
Gold-backed currency ... unless someone invents
a method to produce Gold... :p

And how is it possible to "print money out of thin
air"? Who regulates how much money is being
printed - only the private federal reserve? How
stupid is that to give them this power - being
completely independent from Government and
People... :boggled:
 
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Oliver said:
So what are the solutions if Gold backing the Dollar would be too inflexible for a healthy economy if the FIAT system is a much bigger threat to the economy since it's able to destroy the currency - while this isn't the case with Gold-backed currency ... unless someone invents a method to produce Gold... :p
Click to expand...

There is indeed a method to produce gold. It's called mining. And gold standards create an artificial incentive to do lots of it, which is really quite silly.

But I'm perpetually amused by the idea that we're in a cricis because we don't have a gold-backed currency. Welcome to the modern world. Inflation sucks a hell of a lot less than deflation, especially for the poor. The dollar has a damn good track record as a fiat currency, better than it did as a gold-backed one.
 
Oliver said:
And how is it possible to "print money out of thin
air"? Who regulates how much money is being
printed - only the private federal reserve? How
stupid is that to give them this power - being
completely independent from Government and
People...
Click to expand...

The Federal Reserve doesn't print money. The Treasury does, at the request of the Federal Reserve, and furthermore, the Federal Reserve has to back every single dollar with some asset. It just happens that the vast majority of those assets are Federal bonds (88% as of 2002, looking at my Introductory Macroeconomics textbook, the rest being foreign currency, gold, and loans the Federal Reserve offers to banks) which adds a certain weirdness to things. Also, you can't redeem a dollar for this backing whenever you want, but only when the Federal Reserve decides they want to lower the money supply. Roughly speaking, how it works is that someone has a bond and the Federal Reserve offers to pay for it with them, and the money that they are paid (which is at a competitive price) is equal to the amount of money that the Federal Reserve creates. (Although Partial Reserve Banking ultimately plays an important role in the creation of money too, but that's sort of different.)

Also, to call the Federal Reserve completely independent from the government is not really right. It is somewhat purposefully independent, and private bankers play a significant role, but government appointees play important roles too. Bernanke isn't exactly a figurehead.
 
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